Dreams don't die in China's financial markets; they just go into hibernation. Two years after a collapsing bull market stymied banks' plans to recapitalize, they're rushing again to raise funds before it's too late.

Postal Savings is a good trial case. Its Tier-1 capital ratio is the lowest among major Chinese banks, which means a fresh injection is sorely needed. The government will only let lenders sell new stock at more than book value, but if any bank can manage this it's Postal Savings, which has the cleanest balance sheet among its peers.

Guinea Pig

Postal Savings is a good candidate to test the appetite for China bank IPOs

Source: Bloomberg

Until 2007, when the bank received its first commercial lending license, Postal Savings could only take deposits. As a result, it's been spared the legacy of state-owned "zombie" debt that weighs down rivals. The company's nonperforming loan ratio is only 0.82 percent -- half the level of China Construction Bank Corp. and Industrial & Commercial Bank of China Ltd.

Postal Savings Bank NPL Ratio

0.82%

Rather than a buffer against bad loans, Postal Savings needs capital only because it has been expanding rapidly: In the second quarter, its loan book grew 21 percent from a year earlier.

China desperately wants to capitalize its mid-sized joint-stock commercial banks, which it sees as posing systemic risks. Last year, the People's Bank of China said that if a mid-sized bank were to default, on average four to five other lenders would be affected and more than 8 percent of the industry's capital would be wiped out.

A successful IPO for Postal Savings would help these institutions, which aren't as well capitalized as the big four state-owned lenders.

Buffer Needed

China's mid-sized banks are not as well capitalized as the Big Four state-owned lenders

China's stock markets are looking tempting, with the Shanghai Composite Index having risen more than 10 percent from its May low. On a market-cap weighted basis, Chinese banks are now trading at book value in Shanghai, compared with 0.9 times in Hong Kong. Depressed valuations and Beijing's prohibition on selling shares below book mean there hasn't been a bank IPO on a mainland exchange since July 2015.

So-called CoCo bonds offer another way to strengthen capital, with Postal Savings and China Merchants Bank Co. both getting approval this month to sell the securities, which can be converted to equity or written down to absorb losses if a credit event is triggered.

To be sure, they come at a steep price. China Minsheng Banking Corp., for instance, issued a CoCo at a 4.95 percent coupon last December. Its three-year straight debenture, sold this May, pays only 2.5 percent. The higher cost reflects the risk of conversion; a straight bond will always remain a liability.

Market conditions for CoCos have also improved. This March, China Zheshang Bank Co., a small lender, sold one at a 5.45 percent coupon. Two years ago, Bank of Communications Co., China's fifth largest by assets, issued a CoCo at 5 percent. Zheshang's bond is now yielding only 5.17 percent.

CoCos to Pop?

A flood of CoCo bonds will likely come to market this year

Source: Bloomberg

After a two-year wait, will China's banks move swiftly enough to complete their fundraising before the latest bull market ends? Time will tell.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.